Job Displacement Risk And Severance Pay

This paper is a quantitative, equilibrium study of the insurance role of severance paywhen workers face displacement risk and markets are incomplete. A key feature ofour model is that, in line with an established empirical literature, job displacemententails a persistent fall in earnings upon reemployment due to the loss of job-specifichuman capital. The model is solved numerically and calibrated to the US economy. Incontrast to previous studies that have analyzed severance payments in the absence ofpersistent earning losses, we find that the welfare gains from the insurance against jobdisplacement afforded by severance pay are sizable. These gains are higher if, as in mostOECD countries, severance pay increases with tenure. The result is a consequence ofthe higher persistence of earnings losses for workers with a larger stock of job-specifichuman capital at the time of displacement.